The Dynamics of the Short-Term Interest Rate in the UK
Diether Beuermann (),
Antonios Antoniou and
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Antonios Antoniou: Durham Business School
Alejandro Bernales: Inter-American Development Bank
Finance from University Library of Munich, Germany
We estimate and test different continuous-time short-rate models for the UK. The preferred model encompasses both the “level effect” of Chan, Karolyi, Longstaff and Sanders (1992a) and the conditional heteroskedasticity effect of GARCH type models. Our findings suggest that including a GARCH effect in the specification of the conditional variance, almost halves the dependence of volatility on rate levels. We also find weak evidence of mean-reversion and volatility asymmetries in the stochastic behavior of rates. Extensive diagnostic tests suggest that the Constant Elasticity of Variance model of Cox (1975), with an added GARCH effect, provides a reliable description of short-rate dynamics. We demonstrate that the most important feature in short-rate modeling is the correct specification of the conditional variance of changes in rates; suggesting that the conditional mean characterization is of second order.
Keywords: Short-rate; level effect; GARCH effect. (search for similar items in EconPapers)
JEL-codes: C22 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn
Note: Type of Document - pdf; pages: 27
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Persistent link: https://EconPapers.repec.org/RePEc:wpa:wuwpfi:0512029
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